John Coates who is a Senior Research Fellow in Neuroscience & Finance at the University of Cambridge. He also the author of The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust which I look forward to reading when my next Amazon order arrives at home.
Coates left Wall Street for academia in the past to study what he calls the physical side of trading or the biology of trading behavior. He says that trading is more of a physical activity than a cognitive one. When volatility rises and falls there is a physical reaction to this.
Some of the more interesting points he touched on were –
Single most important thing he has learned is that we have the wrong model of a human being. He says that that financial decision making is not purely a cognitive activity. That everything we do in economics and finance is actually a physical activity. He states that the information interpreted by the mind comes from the body. The point of a brain is to plan and execute movement, not necessarily to think. The reason humans have developed larger brains is to facilitate more complex movements – our bodies and brains have evolved together.
Humans do not have pure thought and every piece of information we come across involves a change in our body as well. Rapid changes in thought are referred to as ‘gut feelings’. There is actually a biological reason for these gut feelings. Our thinking is at our least diluted when we are sending signals to our muscles and at those times our judgment may be at our best. He says we are more closely tied to our bodies than any other animals.
The brain is most sensitive to the unexpected. Also, Coates states that we are addicted to information and that our brain rewards us for unexpected rewards. Humans actually crave risk and do things that result in unexpected reward. However, when traders are stressed they may also become risk averse.
In the financial risk taking arena the risk taking mechanism is not a trait and the risk preference will alter based on circumstances. We take more risks when we are on a winning streak and we are reluctant to take risks when trading is not going well. Your testosterone levels rise when you are winning and drop when you are losing. At a certain point there is an impairment of the physical reward due to too much testosterone.
He finishes up stating that traders will physically respond to volatility whether they are trading or not. Traders have this reaction by just watching the screen. He finished up saying that when we are trying harder at work we seem to neglect our body – this is the worst thing that we can do.